Tuesday, May 20, 2014

Review If the New Years Markets Predictions Came True

Which Asset Class is Living True to Its New Years Resolution?

By Market Authority

“Should Old Acquaintance be forgot, and never thought upon”

Along with singing off-key renditions of “Auld Lang Syne” and making (soon-to-be-broken) resolutions, investors were spending New Year’s Eve 2013 scaling out of their bond positions at the lows of the past year. Towards the end of 2013, it appeared that the long-term love affair with bonds was ending as the Fed began scaling back on bond purchases. However, old acquaintances are not quickly forgot.

Since New Year’s Day 2014, the TLT (the ETF which closely tracks the US Treasury 20+ year bond) has risen 12% and outperformed all major asset classes. The following chart shows TLT’s “dip and rip” in the past year:

And here’s the 2014 performance of TLT vs SPY and GLD:

The Fed has tapered (slowed down) the pace of monthly asset purchases from $85bln a month to $45bln a month. And this taper is expected to continue throughout the year. The largest buyer of bonds is fading out of the picture, yet those assets are still outperforming the market. How can that be?

For starters, this is hardly a new phenomenon. Previous bouts of Quantitative Easing have raised, not lowered, interest rates.

QE programs are intended to raise economic growth and create inflation. In the case of QE3, the Fed is targeting a 6.5% unemployment rate and a 2% inflation rate. When investors expect growth to improve and inflation to pick up, they demand a higher interest rate to lend money. As the Fed ends QE, some investors fear that growth hasn’t quite reached escape velocity, the rate needed to escape the Great Recession and continue on the path of long-term economic growth. Thus, these concerns compel investors to rotate back into safer assets (re: US Treasuries).

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